By: Bill Holter
As I've written before, the Fed really does have to "taper" QE because they have become too big of a player. They are eating up too much Treasury issuance and not leaving enough "collateral" for the shadow banking system to "lever" and lend against. At the same time, foreigners understand that the Fed has become THE only buyer of their bond holdings. As a percentage basis, interest rates have already risen higher and faster than any time in modern history... without "taper" and WHILE the Fed is supposedly going full bore. How badly will interest rates rise (and how badly will prices crash) if the Fed were to back away from the market? The word "credibility" has not come up yet but it's coming I assure you.
I know that I've written about this a couple of times in the last 10 days but this is more important than anything else right now. The Fed has cornered itself, sellers are hitting their bid and soon their credibility will be at stake. "Credibility" is the only thing the Fed has left. This credibility is also the only thing the markets have left. The problem is that credibility is being shredded day after day as foreigners sell our Treasury bonds.
On the one hand the Fed cannot continue taking Treasuries off of and out of the market leaving less and less "quality collateral" but on the other hand they are having to sop up foreign selling. The TIC data as you know showed an outflow of $57 billion in June alone which was the month that interest rates REALLY started moving higher. In other words, the Fed didn't (couldn't?) buy enough to offset the pace of selling. Rates on the 10 year Treasury this morning are 2.92%, this is up from a week ago when we wondered whether they would top 2.75%. This is a disaster waiting to happen.
Can the U.S. economy "grow" with interest rates doubling in 90 days? Can PE multiples in the stock market expand in the face of much much higher rates? Can the $441 trillion derivatives market hold together with this type of movement higher...with the speed that higher rates have occurred? These are all good questions and the answers are certainly not too pleasant...but there is one other question to be asked...
…And shortly it WILL be asked. Can the Fed "fake" its own solvency as interest rates soar higher? This of course goes back to what I wrote above, "credibility". When a "3%" handle gets put on the 10 year and the Fed is sitting on a $400 billion loss, do you suppose the world might start scratching their collective heads and wonder how long the Fed can keep on absorbing losses? Forget about "delta hedging" and that additional push higher to interest rates, foreigners are already rushing the Treasury exits...with the Fed as buyer of last resort and looking more and more like THE only buyer of ANY resort.
We already have "sequestration" and a debt ceiling problem at the Treasury, now the Fed is putting their balance sheet on view for the world to see. What is coming is not about individuals, corporations or even cities and states, no, what is coming is about the solvency of the sovereign U.S. Treasury and Federal Reserve. With that said, as the title implies "they have to taper but they can't". They can't because there is no one else to buy the Treasury's debt nor is there anyone else to buy what foreigners are selling.
Yes, the Fed can (probably will) announce or may even try to taper...but interest rates will sky rocket.
Could 10 year rates go to the crazy and unheard of number of 5%? Could they go to 8 or even 10%? Would this signify that the economy was growing? No, of course not. It would signify a complete loss of credibility. A complete loss of solvency. And of course THE BIG ONE, a complete loss of control! I will end this with a common sense question that has an answer based in common sense but is so horrific that no one wants to go there.
"WHO in their right mind would tie up 10 year money for less than 3% interest (or 30 years under 4%) in a bond with the promise of getting paid interest and paid back principal in a currency that has been grossly over issued (by an insolvent central bank) guaranteed by an issuer (U.S. Treasury) that needs to borrow from their insolvent central bank just to pay the interest?
The answer of course is NO ONE but this is exactly what people are doing by placing money in a bank, money market or even bond funds. ALL of these "safe" investments have their foundation and perceived values based on...the insolvent Ponzi scheme being run between the U.S. Treasury and Federal Reserve.
Source: http://blog.milesfranklin.com/they-have-to-taper-but-they-cant